A recent interaction with the ATO saw a significant client enter into a “Next 5,000” review.  It was a learning experience given the client was new to the firm and we had limited knowledge of the historical transactions.  Nonetheless, the client’s expectations were high:

  • We, as the new financial and tax advisers, needed to show expertise and competence; and
  • The previous advisers needed to demonstrate that they had been diligent in their advice as well as in their record keeping.

Upon further review of the “Next 5,000” program and the ATO’s guidelines thereof, it was apparent that the review was more prospective rather than retrospective. That is, the ATO had a strong focusasset_23.png on the prospective management of tax risk within the group, just as much as they did on historical lodgements and their accuracy. 

This approach stems from the concept of ‘Justified Trust’ and immediately shifts our attention to the future management of tax risk within our client base – how can we best approach and prepare for future reviews?

What is ‘Justified Trust'?

The concept of Justified Trust was originally brought forth by the Organisation of Economic Cooperation and Development (OECD) as a means of assessing various aspects of a taxpayer as it relates to their approach to tax.  This was implemented as a means of building public confidence that the “big end of town” was paying their fair share of tax.  While this was originally implemented with a view to assessing large corporate groups, this concept has found its way into the assessment of large private clients and family groups. 

ATO Programs for Private Clients and Family Groups

Although still in its early stages of development, the ATO’s “Top 500” and “Next 5,000” programs are particularly focused on the tax governance of high net wealth private clients and family groups.

The ATO states that each program "aims to increase willing participation, focusing on prevention rather than correction” of tax outcomes, and “it involves one-to-one engagements with the largest 500 [or 5,000] private groups on an ongoing basis”.

The “Top 500” program seeks to target private groups with any of the following attributes:

  • Over $350 million in turnover; or
  • Over $500 million in net assets; orblue_property_law.jpg
  • Over $100 million in turnover and over $250 million in net assets; or
  • Involves a company with total business income over $250 million and are included in the large company tax gap population; or
  • Are market leaders of groups of specific interest.

On the other hand, the “Next 5,000” program simply targets private groups who, together with their associates, control more than $50 million.

Each program focuses on a defined period during which the ATO attempts to engage with each group to ascertain their willingness to enter an open and transparent process.  This sets the tone for the remainder of the program and on an ongoing basis. 

Good Tax Governance

At the start of the process, the group is expected to supply a raft of financial information.  Most of the information should be easily obtained and provided – e.g. group entities’ details, group structure diagrams, financial statements, tax returns, income tax reconciliations, etc.  However, as you delve into the nuances of obtaining Justified Trust, as opposed to simply satisfying an ATO review, good tax governance is what needs to be demonstrated.

In assessing the group’s tax governance, the ATO focus on four key areas:

1. The effectiveness of the group’s tax governance framework

This implies that there is a robust and disciplined approach to tax matters And it is expected that procedures and controls are in place to mitigate tax risk.  This involves evidencing segregation of tax administration roles and responsibilities, both internal and external to the group, as well as a means of identifying and mitigating such risks.  Ultimately, this needs to be evidenced in documentation, such as a procedure manual or policy document.

2. Identifying tax risks flagged to the market

The ATO regularly issue documentation of tax risks identified as a concern to the market.  Such documents are Taxpayer Alerts, Practical Compliance Guidelines, and Public Rulings.  As part of obtaining Justified Trust, the presence of any such risks will be assessed.

3. Understanding significant and new transactions

The group’s affairs are first considered as a whole to define the business purpose.  Specific transactions are then assessed on their merits, in light of the group’s affairs, to determine if the correct tax treatmentasset_15.png has been applied or that there has not been a change in business purpose. 

A common example is where there is an accumulation of capital items which, following a series of disposal events, might be viewed as revenue items that would give rise to different tax outcomes.  Applying a diligent and structured approach to each transaction, such as keeping documentation and commentary on file, is important to ensure that this is easily addressed upon request. Otherwise, recreating events after the event can be a more difficult exercise, particularly where there is a natural evolution of the group’s business purpose.

4. Understanding why the accounting and tax results vary

Reconciling accounting income to taxable income is an important step in the annual tax compliance process.  Considering the group’s various streams of business activity, the ATO will seek to understand the connection between that which is reported for accounting purposes versus which is deemed taxable income.

The above areas are assessed individually as well as collectively to determine the effectiveness of the group’s tax governance with a view to obtaining Justified Trust.

Unlike ATO reviews that are not exercised under one of these programs, being part of the “Top 500” or “Next 5,000” programs essentially means that, while certain criteria continue to be met, the group will be subject to a re-review every few years – that means the tax risk profile set at your most recent review will apply to your next review.

What's Next?

Who should be prepared for one of these reviews to reasonably demonstrate good tax governance?

  • Anyone who would qualify for the “Top 500” program;blue_risk_2.png
  • Anyone who would qualify for the “Next 5,000” program;
  • Those who expect that they may qualify for either program following a significant, potentially public, events such as a significant sale or listing.

With the ease of access to various types of business information, it can never be assumed that your affairs are not being monitored.  It is, therefore, advisable that if you begin to approach any of the thresholds that may thrust you into the limelight, you should assume that you will be subject to a review and ready yourself to address a query from the ATO.

What can you do to prepare yourself?

  • Establish a Tax Risk Policy document and execute its implementation within your group.  Exercise discipline within your group to evidence compliance with your policy and continue to review, update and re-evaluate outcomes.
  • Document all significant transactions that would not be considered ‘business as usual' as well as the tax risk assessment for each transaction.  This may include purchases, disposals, and restructures.
  • Particularly for acquisitions, consider your funding arrangements and the tax treatment thereof.  It is not uncommon that funds are used within a group to meet the common objective, but the source and use of the funds may have unfavourable tax consequences if not applied correctly.

Establishing a Tax Risk Policy and executing its implementation is the most significant hurdle.  Once this is scaled, however, it is merely a discipline to maintain adequate documentation should you face the prospect of having to participate in one of these programs and demonstrate Justified Trust.

Need more information?

If you have any questions about this article or would like to know more about our services for private clients and family office groups, get in touch with experts at RSM